The idea of earning money without having to work for it is appealing. But a lot of people dream about passive income without ever making a move to turn the aspiration into reality.
One of my favourite passive income ideas is investing money in dividend shares. Here is how I would use £300 a month to do that.
The power of regular saving
Some passive income ideas require a lot of money upfront, like a deposit for buying a rental property. I like investing in shares partly because that is not necessary. In fact, I can start with very little money. By putting aside what I can afford on a regular basis, I should soon start to build up funds I can use to purchase shares.
But other spending priorities often pop up in life. That could derail my plan. So I would discipline myself to set aside the same amount each month, on a regular basis. My goal of £300 is substantial – it would give me £3,600 each year to invest in shares.
Dividend shares as passive income ideas
So, in practice how would that £3,600 help me to earn money?
Many shares pay out dividends, which are basically a tiny sliver of their profits. So if I owned those shares, I ought to earn such dividends. As they are never guaranteed, I would spread my funds over a range of shares. Owning shares in other companies could reduce the overall impact on my income streams if one unexpectedly cut its dividend.
How much might I earn? That will depend on what is known as the dividend yield of the shares I buy. Basically, that is the dividend expressed as a percentage of what I pay for the shares. So if I invest £3,600 into shares with an average dividend of 5%, I would hopefully earn £180 in a year.
Once I own shares, I get any dividends they pay until I sell them. So, over time, my income ought to grow. Not only would I get dividends from shares I had recently purchased, I should also receive them from shares I bought in previous years. With a broad portfolio of dividend shares, I think I could realistically target earning passive income for life.
How to find shares to buy
At the core of this plan is finding shares to buy that will pay me dividends in future. But that requires judgment as nobody really knows what will happen in future. For example, miner Rio Tinto has a 12% dividend yield right now. But if metal prices fall and Rio Tinto’s profit declines, will that still be the case next year, or the year after that?
To manage this uncertainty, I try to buy shares in companies that have a competitive advantage in a market I expect to keep seeing strong demand. I also like companies that live within their means. Very high debt can mean that even a profitable firm has little spare cash to pay dividends after servicing its borrowings.
I think I can find such companies for my income portfolio, as long as I am not greedy and instead focus on searching for businesses with strong financial prospects.